chapter1 awh

8/12/2019 Chapter1 AWH

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Chapter 01 - The Nature And Purpose of Accounting

CHAPTER 1

THE NATURE AND PURPOSE OF ACCOUNTING

Changes from Twelfth Edition

The chapter has been updated.

Approach

On the first day, the usual objectie is to create interest in the subject, to set the scene, and to gie anoerie! of the course. The first part of the chapter does this. The second part of the chapter gies a fairlyspecific introduction to the nature of financial accounting. "nstructors probably #ay !ant to bring in#aterial fro# their o!n reading or e$perience to #a%e the introductory points.

Cases

The cases are intended to get the student to start thin%ing li%e accountants and users of accountinginfor#ation, !ithout %no!ledge of any of the techni&ues. 'ibbons an( )o!s gies students anopportunity to construct a si#ple set of financial state#ents. Kim Fuller can be used as a springboard for

any type of discussion* uses of infor#ation by arious parties, the cost of record-%eeping, or een thedeelop#ent of a co#plete accounting syste#. Baron Coburg illustrates practically all of the basicaccounting concepts, !ithout na#ing the#. "t is a difficult case, but enlightening, een for those !ithso#e prior accounting training.

Problems

Problem 1-1

CHARLES COPA!"

#ALA!CE SHEET AS O$ %ECE#ER &1' ----(

Assets Liabilities and Owners) E*+it,

Cash..........................................................................................................................................................+ 1,000 )an% loan.............................................................................+ 0,000"nentory................................................................................................................................................../,000 O!ners( &uityOther assets..............................................................................................................................................1,000 O!ners( e&uity..................................................................20,000

Total assets..............................................................................................................................................+10,000Total liabilities ando!ners( e&uity......................................................................+10,000

This proble# can be used to e$plain certain accounting presentation conentions. 3or e$a#ple, the use ofdouble lines to underscore a total, the position of the dollar sign at the top of a colu#n of nu#bers, andthe dating of the balance sheet.

The purpose of this proble# is to illustrate the e&uality of the basic accounting e&uation* assets e&ual

liabilities plus o!ners( e&uity.

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Problem 1-

The #issing nu#bers are*

4ear 1

Noncurrent assets.............................................................................................................................................................+10,56Noncurrent liabilities........................................................................................................................................................0,/12

4ear

Current assets..................................................................................................................................................................+ 0,Total assets.....................................................................................................................................................................22,/6Noncurrent liabilities........................................................................................................................................................52,/2/

4ear

Total assets.....................................................................................................................................................................+5,1/Current liabilities............................................................................................................................................................1/,/2

Total liabilities and o!ners( e&uity..................................................................................................................................5,1/

4ear

Current assets..................................................................................................................................................................+ 6,00Current liabilities............................................................................................................................................................15,/

The basic accounting e&uation is

Assets 7 8iabilities 9 O!ners( e&uity

The instructor #ight !ant to e$plain ho! this e&uation is used :as it is in this proble#; to calculate


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Problem 1-&

The #issing nu#bers are*

4ear 1

>ross #argin.......................................................................................................................................................+,000Ta$ e$pense........................................................................................................................................................1,10

4ear

?ales....................................................................................................................................................................+11,62Profit before ta$es...............................................................................................................................................,/5

4ear

Cost of goods sold.............................................................................................................................................................................................................................................

+,226

Other e$penses....................................................................................................................................................6,6

Other accounting e&uations such as the follo!ing are also illustrated by this proble#*

>ross #argin 7 ?ales - Cost of goods sold

Profit before ta$es 7 >ross #argin - Other e$penses

Net inco#e 7 Profit before ta$es - Ta$ e$pense

The instructor #ay !ant to point out to the students that ratios are often used by #anagers to constructprojected financial state#ents. 4ear is an e$a#ple of this application.

"n order to esti#ate 4ear , the %ey ratios to co#pute are*

"ear 1 "ear "ear & A.erage

?ales.................................................................................................................................................................... 100.0@ 100.0@ 100.0@ 100.0@>ross #argin.......................................................................................................................................................5/.0 5/.0 5/.0 5/.0@Profit beforeta$es..................................................................................................................................................................... 1. 0./ 1.5@Net inco#e..........................................................................................................................................................1.0 1.2 1. 1.0@Ta$ rate...............................................................................................................................................................0.0 0.0 0.0 0.0

4ear

?ales....................................................................................................................................................................+10,000

Cost of goods sold............................................................................................................................................... ,/00>ross #argin :5/@ of sales;...............................................................................................................................+ 5,/00Other e$penses.................................................................................................................................................... /,0Profit before ta$es :1.5@ of sales;....................................................................................................................+ ,150Ta$ e$pense........................................................................................................................................................250Net inco#e :1@ of sales;...................................................................................................................................+ 1,00

The basic accounting e&uation used is* Net inco#e 7 'eenues $penses

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Problem 1-/

The e$planation of these 11 transactions is*

1. O!ners inest +0,000 of e&uity capital in Ac#e Consulting.

. &uip#ent costing +5,000 is purchased for +/,000 cash and an account payable of +,000.

. ?upplies inentory costing +1,000 is bought for cash.

. ?alaries of +,/00 are paid in cash.

/. 'eenues of +10,000 are earned, of !hich +/,000 has been recoered in cash. The re#aining +/,000is o!ed to the co#pany by its custo#ers.

6. Accounts payable of +1,/00 are paid in cash.

5. Custo#ers pay +1,000 of the +/,000 they o!e the co#pany.

2. 'ent $pense of +5/0 is paid in cash.

. Btilities of +/00 are paid in cash.

10. A +00 trael e$pense has been incurred but not yet paid.

11. ?upplies inentory costing +00 are consu#ed.

ACE CO!S0LT!2

#ALA!CE SHEET AS O$ 30L" &1' ----(


Cash.................................................................................................................................................................................+1,5/0 Accounts payable...........................................................................+ 500Accounts receiable.........................................................................................................................................................,000?upplies inentory............................................................................................................................................................ 200

Current assets...........................................................................................................................................................15,//0 Current liabilities...........................................................................500&uip#ent........................................................................................................................................................................ 5,000 O!ners( e&uity...............................................................................,2/0

Total assets.....................................................................................................................................................................+,//0Total liabilitiesand o!ners( e&uity.........................................................................+,//0

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ACE CO!S0LT!2

!COE STATEE!T 30L" 1 - &1' ----(

'eenues...................................................................................................................................+10,000$penses

?alaries.................................................................................................................................,/00'ent......................................................................................................................................5/0Btilities................................................................................................................................./00Trael....................................................................................................................................00?upplies................................................................................................................................ 00 6,1/0

Net inco#e.......................................................................................................................+ ,2/0

ACE CO!S0LT!2

CASH RECEPTS A!% %S#0RSEE!TS' 30L" 1 - &1' ----(

'eceiptsO!ners( inest#ent..............................................................................................................+0,000Cash sales............................................................................................................................./,000Collection of accounts receiable......................................................................................... 1,000

Total receipts...................................................................................................................+6,000Disburse#ents

&uip#ent purchase.............................................................................................................+/,000?upplies purchase................................................................................................................. 1,000?alaries paid..........................................................................................................................,/00Pay#ents to endors.............................................................................................................1,/00'ent paid..............................................................................................................................5/0Btilities paid......................................................................................................................... /00

Total disburse#ents........................................................................................................+1,/0"ncrease in cash................................................................................................................+1,5/0

The change in this cash account includes the o!ners( inest#ent, !hich is not an inco#e state#ent ite#.The inco#e state#ent includes reenues and e$penses that hae not yet been receied in cash or paid incash. The cash paid to purchase the e&uip#ent is not reflected in the inco#e state#ent. :"t is probablybest if the instructor does not discuss depreciation at this point in the course.;

This proble# illustrates seeral i#portant points that #anagers should understand. These are*

a. ery transaction inoles at least t!o accounts.

b. Net inco#e is not e&uialent to the net change in the cash account during an accounting period.

c. Cash is influenced by both balance sheet and inco#e state#ent eents.

d. The basic accounting e&uation :Assets 7 8iabilities 9 O!ners( e&uity; can be used to capture,illustrate, and e$plain the accounting conse&uences of #any :but not all; transactions and eents thatinole a co#pany.

The cash receipts - disburse#ents display is used since it !ould be pre#ature to introduce the cash flo!state#ent display at this point in the course.

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Problem 1-4

Cash 5 Acco+ntsRecei.able 5 S+ppliesn.entor, 5 E*+ipment 6 Acco+ntsPa,able 5 Owners)E*+it,

1. 9 +/,000 9 +/,000 "nest#ent. - /00 - /00 'ent. 9 +2,000 9 +2,000. - /00 9 +/00/. - 5/0 - 5/0 Adertising6. - ,000 - ,000 ?alaries5. 9 ,000 9 +2,000 9 10,000 Co##issions2. - /,000 - /,000. - 100 - 100

10. 9 1,000 - 1,000 $penses

#O! 7O"A2E TRA7EL

#ALA!CE SHEET AS O$ 30!E &8' ----(


Cash....................................................................................................................................................................+15,/0 Accounts payable.........................................................................+ ,000Accounts receiable............................................................................................................................................2,000 Current liabilities.....................................................................,000?upplies inentory...............................................................................................................................................00 O!ners( e&uity.............................................................................,6/0

Current assets................................................................................................................................................/,6/0&uip#ent...........................................................................................................................................................+ 2,000

Total Assets...............................................................................................................................................+,6/0Total liabilitiesand o!ners( e&uity..............................................................+,6/0

#O! 7O"A2E TRA7EL

!COE STATEE!T 30!E 1-&8' ----(Co##issions..........................................................................................................................................+10,000$penses................................................................................................................................................

'ent...................................................................................................................................................+/00Adertising........................................................................................................................................5/0?alaries..............................................................................................................................................,000?upplies.............................................................................................................................................100Eisc. $penses..................................................................................................................................1,000 /,/0

Net "nco#e....................................................................................................................................+ ,6/0

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#O! 7O"A2E TRA7EL

CASH RECEPTS A!% %S#0RSEE!TS 30!E 1-&8' ----(

'eceiptsO!ners( inest#ent.................................................................................................................+/,000Collection of co##issions.......................................................................................................,000

Total receipts....................................................................................................................+5,000

Disburse#entsPaid rent...................................................................................................................................+ /00)ought supplies......................................................................................................................./00)ought adertising...................................................................................................................5/0Paid salaries...................................................................................................................................................................................................................................

,000

Paid endors............................................................................................................................/,000Total disburse#ents.........................................................................................................+ ,5/0

"ncrease in cash....................................................................................................................+15,/0

?ee Proble# 1- for !hy change in cash account and the #onth(s inco#e are not the sa#e.

The proble#(s purpose and lessons for #anagers are si#ilar to those in Proble# 1-.

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Case 1-1: Ribbons an Bows, Inc.

!ote9 This case is unchanged from the Twelfth Edition.

Approach

This is an introductory case and it should be taught as an introductory case. There !ill beplenty of ti#e in the course for the students to learn the correct for# of financial state#ents anddetails of accounting standards. "n short, the instructor should be prepared to allo! a ariety offor#ats for the financial state#ents and tolerate so#e


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11.1. No depreciation is recorded on the cash register loaned by the local credit-card charge

processor and the furniture left by the for#er tenant. These


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"n addition, students beliee Car#en(s nonrecognition of any cost associated !ith usingthe abandoned counters and display e&uip#ent oerstates ho! !ell she is doing fro# anecono#ic point of ie!. These students !ould include so#e depreciation cost based on theasset(s fair alue in their ealuation of ho!


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?e!ing Eachine :1,200;nding Cash +,0

E;hibit &

Ribbons an) #ows

#alance Sheet as of 3+ne &8' 818

Assets 8iabilitiesCash +,0 Jages o!ed +0Accounts receiable 0 "nterest o!ed 00

Eerchandise "nentory ,100 Cousins( loan 10,000?upplies 0 +10,0Prepaid rent 1,00 O!ner(s &uityCo#puter :net; 1,5/0 Car#en(s e&uity +1,000?e!ing #achine :net; 1,50 arnings 1,20Cash register deposit /0 +,20Total +1,550 Total +1,550

Case 1-2: Kim Fuller

!ote 19 This case is updated from the Kim Fuller case in the Twelfth Edition.

!ote 9 The instructor should be aware that the name, Kim Fuller, could refer either to a male or a

female. The case uses no pronouns that indicate gender to refer to Kim Fuller; the gender of

Kim Fuller has been left open to interpretation by the students and/or the instructor.

Approach

This case is not, as it #ay appear to be, an


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Comments on :+estions

An opening &uestion #ight be,


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Iuestion proides the opportunity to introduce the ti#e period, #atching, and #ateriality concepts,although so#e of the basic concepts in Chapter #ay be too difficult to introduce at this point :e.g.,conseratis#;. "t #ay also be possible to introduce the distinction bet!een product costs and period costs.Iuestion together !ith Iuestion also naturally leads to the distinction bet!een financial accountingand #anage#ent accounting. Jith only a fe! fa#ily #e#bers as o!ners, and !ith the ban%(s #ortgage

on the building !ell secured :by definition;, the co#pany(s financial reporting re&uire#ents are rather#ini#al. "ndeed fa#ily-o!ned businesses of this s#all siHe and si#plicity often prepare annual financialstate#ents for ta$ purposes, and then distribute these sa#e state#ents to the fa#ily o!ners and ban%.o!eer, 3uller !ould be !ell adised to hae inco#e state#entsand probably also cash flo!state#entsprepared at least &uarterly, and perhaps #onthly, to help ensure that the business is notslipping into any financial holes. These !ould be #anage#ent accounting reports, but they #ay, ofcourse, be shared !ith the inestors. :The ?#all )usiness Ad#inistration periodically reports that poor#anage#ent accounting records, particularly inade&uate records of productGproduction costs, are a #ajorcause of s#all business failures;. Blti#ately, 3uller !ill hae to judge the e$tent of the need :and costjustification; for preparation of for#al #anage#ent accounting reports to supple#ent 3uller(s personalobseration of the business. Of course, the proble# encountered by #any businesses is that reports arenot introduced as the business gro!s and beco#es too co#ple$ to be #anaged pri#arily by the personal

obseration of its o!ner-founder-general #anager, and this person slo!lyoften, un!ittinglylosescontrol of the business.

"n su#, students should glean fro# their discussion of this case the idea that there are so#e accounting


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Comments on :+estions

The first issue confronted by the students is the definition of the entity. As Iuestion 1 i#plies, each plotcan be regarded as an entity, een though both plots are o!ned by the )aron. :?tudents should realiHe thisearlier because the )aron is referred to as a appraisal is the only aailable aluation basis. ?i#ilar co##ents apply to the o$en.

At this point, deelop#ent of the balance sheet can begin. " find it useful to deelop an intuitie conceptof an asset, and then say that as each asset is alued, !e !ill also record !ho proided the financing forthe asset, and !ho, therefore, has a clai# :e&uity; against the entity(s assets. This leads to the beginningbalance sheets for the far#s, as sho!n belo!.

Note that " hae not called the Plot !or%ed by "an


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#ALA!CE SHEET $OR PLOT


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"t is i#portant to bring out ho! production assets :as opposed to #onetary assets; beco#e e$penses as theassets proide their utility. This is straightfor!ard for the seed and fertiliHer but less so for o$en andplo!s. Also, students need to see that so#e of the !heat production has been distributed to theplo!#a%er and to the o!ner, !ith the result that these production a#ounts are larger than those sho!n

for Jheat on the ending balance sheet. " also point out that although !e hae treated the !heat producedas reenues, in practice, reenues are usually based on goods sold, not goods produced. :As a #atter offact, the


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!COE STATEE!T $OR PLOT

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